Traders Search for Pullback Trigger as Fears Rise

With volatility low and complacency high, traders are searching for the spark that could trigger a market pullback.

Stocks Tuesday finished sharply higher with the Dow up 99 at 13,979, its third big move in a row. The S&P 500 was up 1 percent at 1511, and the Nasdaq was up 1.3 percent at 3171.

There are some major earnings Wednesday, including Time Warner, Glaxo Smithkline and Marathon Oil, but no economic reports for the markets to focus on, except for mortgage application data at 7:00 a.m. ET. Oil and gasoline prices could also get attention, when government inventory data is released at 10:30 a.m.

While traders have been chatting about the potential for a pullback from near record highs, the VIX, a measure of market fear, fell 6.5 percent, to 13.72 Tuesday. The VIX reflects market expectations of near-term volatility and is a metric of the out-of-the-money puts and calls on the CBOE.

"There's a lot of people that will equate low volatility with a pullback, but typically volatility goes lower as the market goes higher. It only makes sense," said Patrick Kernan, who trades S&P 500 options with Cardinal Capital.

But Kernan said the talk of a pending pullback is picking up as the market flirts with record highs. "It feels like people are really searching out why or what event will push it down, and they want to be the first ones out," he said. "You hear whispers of it all over the place." In the vacuum of much news, traders are talking about what they think could bother the market, and Europe and the fiscal issues in Washington top the list.

Even with a low VIX, the market has had its most dramatic moves in weeks in the past three sessions. The Dow last made a triple digit move on the first trading day of the year, but it made triple digit moves in the last three sessions. "I think on a dip, you can buy the market overall. We've had a good run here to 14,000 in the last month, so we'll have a pause," said Paul LaRosa, chief market technician at Maxim Group. "Then you could have a constructive correction that could provide a better entry point in general."

LaRosa said the three big market moves since February began show uncertainty and could be precursor to a sell off. "A big swing in the market might mean a correction is in order. But if we get a close over 14,020 that would ease my concern," he said, referring to Friday's high on the Dow.

BMO Private Bank CIO Jack Ablin said he's keeping an eye on the volatility. "It's just remarkable that the volatility continues to fall. Historically it's eery. What it means is in periods where we have this kind of environment in four to five periods, we're okay, and one out of five times you get a big dump to the downside," he said.

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The market is also supported by a stream of somewhat better economic data, but not so good that the Fed will stop easing. "The Fed is stopping anything bad form happening, and we're going to keep gradually going forward," said Kernan. "It's like walking forward. We're going to go two steps forward, one step back. That's what the market is implying right now."

LaRosa said he's positive on stocks, but not super bullish because he is watching the Nasdaq, which is lagging after other indexes have broken through multiyear highs. "I want to see it close over 3200 before getting too bullish on the upside," he said. The Nasdaq has been held back by the weak performance of technology. The S&P tech sector has been the worst performance since the beginning of the year, up just 2.3 percent year-to-date but up 1.4 percent Tuesday.

Since January 1, the Nasdaq is up five percent and the S&P 500 is up six percent. The Dow is up 6.7 percent.

LaRosa said even as the market head to highs, investors who are still jumping in are supporting the market's gains.

"It's the fear of missing the rally," LaRosa said. "People are saying, 'I missed it in 2009 and I don't want to miss it now.'"

"This market is a little different. It's still sector specific. Not everything is working. That gives me a little pause to think that this is a rally that is going to have tremendously long legs," he said.